by John M. Curtis
(310) 204-8700

Copyright September 21, 2007
All Rights Reserved.

eacting to Wall Street's moaning-and-groaning, Federal Reserve Board Chairman Bernard S. Bernanke gave the market instant gratification, cutting the Discount Rate—the rate the Fed charges other banks—50 basis points. Wall Street returned the favor, rocketing up 300 points or 2.5%, as institutional investors jumped back into the market. Only a few weeks ago, the Fed was worried about inflation, resisting the temptation to slash interest rates. Despite President George W. Bush's rosy forecast, Bernanke was more concerned about recession than inflation, cutting the Discount Rate one-half percent. President Bush said the economy was strong, despite Bernanke offering emergency medicine. No Fed chairman slashes rates, like Greenspan did after Sept. 11, unless the economy needs urgent resuscitation. Slashing rates signals the economy is in trouble.

      Bernanke tried to reassure sick credit markets that the Fed wouldn't let the subprime mortgage meltdown spoil the overall economy. Pandering to Wall Street now gets the Fed into hot water, watching long-term bond yields jump. Pushing up rates on the 10-year Treasuries hurt the real estate market, making mortgages more expensive and driving down prices. No matter what the Congress does to give borrowers relief from defaults on subprime mortgages, foreclosures are spiraling out of control. Mortgage defaults and foreclosures hurt the economy by paralyzing consumer spending, especially home equity lines that have kept the economy rolling for several years. Reeling from Iraq, the GOP isn't helped by economic woes, signaling it's time for new management. Slashing interest rates traded one set of problems for another, as the U.S. dollar hit record lows against the Euro.

      Bernanke knew that yields on U.S. Treasuries were not keeping pace with the dollars' devaluation against foreign currencies. Slashing the Prime Rate—the rate banks charge corporate customers—increases short-term liquidity but squeezes long-term borrowing. “The markets certainly are testing Mr. Bernanke,” said Tom Di Gaioma, head of Treasuries trading at the brokerage Jefferies & Co. in New York, worried about the precipitous jump in the 10-year Treasury note from 4.54% to 4.70 on Sept. 20. Bernanke would rather devalue the dollar and drive the costs up on mortgages than watch corporate employers cut payrolls. Last month's jobs report, showing a dramatic reversal in growth, raised the specter of recession, leading to Bernanke's actions. Bernanke knows that if the stock market continued to sell-off, publicly-traded companies will begin trimming payrolls.

      Unemployment doesn't help the real estate market, where stable jobs qualify borrowers for long-term debt. Keeping credit cheap, helps businesses finance more expansion, including adding to payrolls. Since Bernanke slashed rates Sept. 18, commodity prices, including gold and crude oil, have gone through the roof, signaling more inflation and the rise in long-term bond prices. While improving exports, devaluing the dollar hurts imports and foreign travel. “I don't think the [Fed's move] has in any way backfired,” said Brian Bethune, an economist at Waltham, Mass.-based Global Insight Inc., insisting the fight against recession has priority over battling inflation. Rapid rises in crude oil prices could fan inflation by adding to the costs of everything from air travel to string-bikinis. Lowered consumer spending and higher commodity prices could cause renewed stagflation.

      Propping up the sagging dollar is going to be difficult with lowered interest rates. Europe's and the UK's central banks have resisted cutting interest rates, to maintain the strength of currencies. Bernanke should put some heat of Europe's central bankers to cut rates to help a sagging dollar. U.S. tourism has always propped-up European economies, as manufacturing shifted to abroad. If the dollar remains in a freefall, it's going to hurt U.S. treasuries, causing a cash-crunch. No foreign investor wants to collect meager interest on devaluing investments. “Gold has become the best long-term barometer of people's perception of a country or an economy,” said Peter Grandich, the editor of the Grandich Letter from Wall, N.J. When the dollar sinks, gold becomes the best hedge against currency devaluation. Rising gold and commodity prices signal a sick economy.

      Bernanke and the Federal Reserve have the best access to data revealing the health or sickness of the economy. Economists at the Fed read the tealeaves and determined that the economy required emergency medicine. While there's no room for panic yet, it's unlikely Wall Street's current run-up can last without a significant correction. Wall Street's institutional players know when it's time to buy and sell. Small investors get hung out to dry when programmed trading upends the market. If earnings drive the market, there's selling on the horizon. Next time Wall Street decides to sell, Bernanke won't be able to reverse a selling frenzy by lowering rates. Bernanke must put more heat of European and U.K. central bankers to cut rates. If not, the weak dollar could fuel inflation and sabotage the economy. When Wall Street whines again, Bernanke should tell them where to go.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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